Giant Fraud Claims First Corporate Victims in Insurance Industry

By JOSEPH B. TREASTER

Published: June 28, 1999

The effects of a giant insurance fraud involving a Connecticut money manager are rippling across the industry and have already claimed their first two corporate casualties.

Faced with sudden, overwhelming losses as a result of the scandal involving more than $300 million in missing money, a small Virginia life insurer was seized by state regulators, and a New York insurance company confronted with $67 million in unexpected liabilities was forced into a merger.

The downfall of the two insurance companies -- the Capital Re Corporation of New York and the Settlers Life Insurance Company of Bristol, Va. -- occurred in recent weeks, but their connection to the scandal involving the money manager, Martin R. Frankel, has emerged only in the last few days.

The two companies' troubles underscore what may be one of the most significant aspects of the scandal: the fundamental structure of the insurance business means that companies across the industry -- and not just those directly linked to Mr. Frankel -- are potentially at risk.

Government investigators think Mr. Frankel, a reclusive Greenwich, Conn., money manager who vanished in early May, orchestrated a fraud over almost a decade in which he embezzled huge sums of money from insurance companies that he controlled.

But neither Capital Re nor Settlers Life was controlled by Mr. Frankel. Rather, they did business with his companies. As the scandal unfolded, both companies found themselves liable for huge sums of money as a result of their transactions with the Frankel empire.

Insurance experts said such damage could continue to spread through the industry as other transactions with companies controlled by Mr. Frankel were uncovered. Even insurers that had no dealings with the companies under Mr. Frankel's control are likely to suffer financially. They will be required to contribute to funds designed to make sure policyholders do not suffer losses. Potentially, the contributions to the fund could lead to increased premium costs for other policyholders.

Regulators estimate losses to Capital Re of about $67 million. They put the Virginia company's losses at about $44 million. Most of the tens of thousands of policies in seven companies controlled by Mr. Frankel provided benefits of less than $5,000 each and were designed to pay for funeral costs, regulators said.

Repeated calls to the offices of Capital Re and to executives' homes on Friday afternoon were not returned. Settlers Life referred calls to state regulators.

Both companies were involved in reinsurance, insurance that backs up the coverage of other insurers and is widely used in the industry to spread risk. In Capital Re's case, a subsidiary acted as an intermediary between one of Mr. Frankel's companies and other insurers.

Steve Divine, the chief financial examiner for the Missouri Department of Insurance, said the Capital Re subsidiary received a commission for passing $67 million in policies to Mr. Frankel's companies. According to Virginia and Mississippi regulators, Settlers Life dealt directly with the First National Life Insurance Company of America, a Mississippi company under Mr. Frankel's control, transferring its own assets and deducting a portion as a fee for itself. Under insurance law, Capital Re and Settlers Life remained liable for the policies.

Because of the lingering liability, it is vital for insurers to accurately assess the financial strength of companies to which they pass on or cede business. The Frankel-controlled companies that Capital Re and Settlers Life dealt with, like most of Mr. Frankel's companies, had low financial ratings. Most were equivalent to junk bonds. Regulators said that, just as with issuers of junk bonds, it is likely that Mr. Frankel paid higher-than-usual fees to entice companies to transfer assets to him.

Insurers that seek assets from other companies calculate that they will be able to trim administrative costs and raise profits through economies of scale. Many also think that their investing skills will enable them to increase earnings on the assets.

Mr. Frankel portrayed himself as an investing wizard. But regulators say it now appears that his real objective was to amass money in his insurance companies that he could siphon off through his investment company, Liberty National Securities.

The effects of his dealings with Settlers Life were devastating. The company began the year with a comfortable $23 million in capital and surplus. But with the loss in Mr. Frankel's company, Settlers suddenly found itself more than $25 million short of the minimum of $4 million in capital and surplus that Virginia requires of insurers, and the regulators stepped in.

The losses with Mr. Frankel's companies were the latest in a series of blows to Capital Re, which specializes in reinsuring relatively low-risk bond insurance. It was forced to set aside $44.1 million to cover claims on securities sold by Commercial Financial Services, a credit-card debt company that sought bankruptcy protection last December. It also reported potential losses of as much as $10 million in the insolvency of a Pittsburgh hospital system. In December, Michael E. Satz, who had been chief executive since helping to found Capital Re in 1988, was replaced by Jerome F. Jurschak, another founder.

In February, Ace Ltd., one of the world's leaders in high-stakes commercial insurance, agreed to provide Capital Re with $75 million in exchange for a 12 percent stake in the company.

In March, Moody's Investors Service cut Capital Re's financial rating by two notches from Moody's highest level, and the insurer's stock value dropped 16 percent. Ace then negotiated more favorable terms on its investment.

An insurance trade publication, the National Underwriter, reported in April that Ace was offering to buy Capital Re. But, the trade paper said, Capital Re executives were unwilling; the company's stock would have to rebound before they agreed. The stock was then trading at $19.25.

But over the Memorial Day weekend, with its stock several dollars lower, Capital Re simultaneously disclosed $67 million in losses and its decision to accept a merger offer from Ace for about $600 million in stock. That worked out to about book value. Analysts said similar companies would be expected to sell for one and a half to two times that.

When Capital Re disclosed the losses, Mr. Frankel's connection with the failed companies was not known. Initially, the regulators' seizure of Settlers Life also appeared to be an isolated case.

Several analysts said the latest losses would have increased pressure for another reduction in financial ratings, which might have been disastrous for Capital Re. But by joining with Ace, which has an estimated $31 billion in assets, Capital Re's finances were immediately shored up.

''They didn't have much of a choice,'' Ira Zuckerman, an analyst at Nutmeg Securities, said. ''They pretty much had to take Ace's offer.''

Matthew L. Vetto, an analyst at Salomon Smith Barney, said that in Capital Re's area of specialization, backing up bonds, high financial ratings are essential. ''Contracts are signed on the basis of credit quality,'' he said. ''If that changes, the business can leave.''

Chart: ''The Money Trail'' The Government has said that Martin R. Frankel, operating under several aliases, defrauded a group of insurance companies out of hundreds of millions of dollars in an elaborate scheme that involved shell corporations and offshore bank accounts. Here is what the Government said happened in one transaction. Settlers Life Insurance Company April 9, 1999 Bought reinsurance from the First National Life Insurance Company of America, a company controlled by a Frankel foundation, for $44 million. First National Bank of Tennessee April 9, 1999 Settlers wired the money into an account First National had at this bank. Dreyfus Company April 9, 1999 First National transferred the money to an account at Dreyfus managed by Liberty National Securities, a company run by Frankel. UBS Stamford Bank April 12, 1999 The money was wired to a clearing account used by a Geneva-based bank, Banque SCS Alliance. Banque SCS Alliance April 12, 1999 The money ends up in a Swiss bank account opened by Bloomfield Investments, a company owned by David Rosse, an alias of Frankel. (pg. C8)